The Price Of Safety

Telecom is another income-oriented sector that has seen strong year-to-date performance (+24%, as measured by the S&P 500 telecommunications sector), though the fact that two stocks make up more than 90% of the market capitalization of the sector means returns are driven more by the performance of individual companies, making comparisons less meaningful.



While the low-rate environment and demand for yield have helped the performance of these sectors, investors may be paying too high a price for safety of these traditionally less volatile areas of the stock market. The high valuations of not only high-quality bonds but also defensive equity sectors should be questioned by prudent investors with a long-term horizon. Areas of stock and bond markets traditionally considered “conservative” or “safe” may provide short-term confidence given stubbornly low interest rates, but may fail to help investors achieve longer 5-, 10- or 20-year objectives. Investors may be taking on more risk than they are aware, given that stock prices, historically, tend to be more volatile than bonds over time, and that a rise in interest rates also remains a risk for these sectors.

CONCLUSION
The price of safety has increased in recent years, leading investors to move into more volatile areas of the market in order to obtain reasonable yields. Although this stretch has worked so far, aided by historic liquidity from global central banks that has helped to drive asset prices higher, investors may be overpaying for perceived safety and peace of mind. While yields remain historically low and recent central bank actions point to potentially lower rates for longer, a sudden increase in economic growth or inflation (for headline inflation, this could be driven by something as benign as oil prices remaining at current levels), which drives rates higher could surprise investors in rate-sensitive sectors, including defensive equities. Investors should take the time now to assess the overall risk levels of their portfolios, as principal losses from a move higher in interest rates may easily overwhelm the benefits of additional yield, especially given the stretched valuations of many income-oriented sectors of the market.

Anthony Valeri is fixed-income and investment strategist for LPL Financial.